It comes a time when you need to stop working and put your money to work. Quality investing ensures present and future financial security. The best way to get high returns on your investment is to be able to see value where others don’t.
What is value investing? It’s a strategy that involves picking stocks that seem to be trading for less than their intrinsic or book value. Value investors believe that the market overreacts to news, which causes shifts that don’t correspond to a company's long-term fundamentals. It provides them with the chance to buy stocks at discount prices.
Seth Klarman: Investors Can No Longer Rely On Mean Reversion
"For most of the last century," Seth Klarman noted in his second-quarter letter to Baupost's investors, "a reasonable approach to assessing a company's future prospects was to expect mean reversion." He went on to explain that fluctuations in business performance were largely cyclical, and investors could profit from this buying low and selling high. Also Read More
In gambling, the term is also used as “value betting”, the practice of finding a bet at odds that provides you an edge over the bookmaker. Possible in sports betting, and only possible in online casinos when playing poker.
Those with some insight may ask - is value investing dead? The answer depends on how you view things. If you look at the metrics, yes, it is. You invest by looking into the rearview mirror. If you invest based on intrinsic value and a margin of safety, it’s the best way, now, and beyond.
Below, let us look at notable value investing case studies and learn about the results this practice may yield.
1. Buffett and Geico
According to many, Warren Buffett is the best stock market investor of all-time. He has a very public and proven track-record on how to value-invest applying Benjamin Graham’s principles. Over the years, he and Geico have become a synonymous tale of great investing.
Throughout its history, Geico has dominated the car insurance landscape by directly selling to consumers at a lower cost than competitors. The company’s acronym stands for Government Employees Insurance Company. However, like with all companies, it too has gone through peaks and valleys.
A 21-year-old Warren Buffett became first interested in the company upon learning that Benjamin Graham was the chairman on its board. He was Buffett’s hero, who had bought his book – The Intelligent Investor, at 19 years-of-age, and re-read it over a half-a-dozen times. In 1951, Buffett visited the company’s office and spoke to Lorimer Davidson, who would later become CEO.
Buffett put 65% of his fortune of $20,000 into Geico, once he learned that Graham invested 25% of his capital in 1948. Graham acquired 50% of the enterprise for $712,000, a sum that would grow over to $400 million some 25 years later.
Buffett sold his initial stock after a small gain to pursue other opportunities, a decision that he would regret, as his initial $13,000 investment would have reached $1.3 million in a few years. Nevertheless, he continued to follow the company and write articles about it.
In 1972, Geico’s stock price hit $61 per share, its highest number. Yet, a few years later, it dropped to as low as $7.
The company tried to fix things by relaxing the premium-to-surplus ratio, and by growing out of the high-quality driver’s niche. Though that didn’t help and losses grew. In 1976 the company was facing bankruptcy. By then, Buffett had re-entered Geico and was on the board of directors. He hired Jack Byrne, an insurance executive to fix things. Believing in his choice, Buffett pounced on distressed share prices, purchasing $4.1 million in common shares, and $19.4 million in convertible preferred stock.
The company fired half of its employees, raised premium prices, and exited unprofitable markets. By 1977, Buffett’s common stock saw a jump of 150%, and the preferred stock doubled. Three years later, Buffett invested $45 million more in the company, and throughout the decade he increased Berkshire Hathaway's ownership to 50%. In 1995, Berkshire bought out the remaining 49% for $2.3 billion. Meaning, their $45.7 million grew to $2.3 billion, a gain of 5,136% in 15 years.
2. Singleton and Teledyne
Henry Earl Singleton was an electrical engineer, a business executive, and a rancher. Born and raised in the small Texas town of Haslet, Singleton went to MIT, where he earned a Ph.D. in Electrical Engineering. It wasn’t until he was in his mid-40s that his investing career started. In June of 1960, Singleton, alongside his colleague from Litton Industries, George M. Kozmetsky, formed Instrument Systems, a venture capital firm financed with a $450,000 investment.
They bought rights to the name Teledyne, a short time after, with the idea that they would create a firm that would combine semiconductor device fabrication and control system development by acquiring existing companies. Five months later, they purchased majority stock in Amelco, an electronics manufacturing plant. By the end of 1960, they acquired two more electronic companies.
In May of 1961, Teledyne stock went public as the conglomerate era was starting on Wall Street. Within ten years, Singleton purchased 130 companies, mainly in fields such as insurances, electronics, dental appliances, and specialty metals. He focused on growing companies in niche markets. At various times Teledyne had more than 150 companies under its umbrella.
During 1961-1971, Teledyne’s earnings per share rose 65-fold to $8.55. In the following thirteen years, Teledyne put more of a focus on organic growth and wasn’t as active with acquisitions. It paid off as the earnings per share grew 40-fold to $353.
As the largest investor in the conglomerate, Singleton made money alongside his investors, not from them. He never granted himself options.
When conglomerates fell out of favor in the 1970s, the stock dived. P/E dropped from the 20-50 range to below 10 times. Singleton spent $2.5 billion to repurchase over 90% of the company’s shares, at eight times earnings. The stock had four bad years, but then, it started to climb back up, it rose from the ashes and ranked among the best-performing stocks in the country.
In 1974, Teledyne stock fell below $8. However, by 1978, it was over $100.
Teledyne ignored brokers and put a focus on long-term value creation. It was able to do this due to its small board that controlled 40% of the shares.
In the mid-1970s, Singleton began managing the investment portfolios of the insurance subsidiaries. He ran a concentrated portfolio. He reallocated assets, increasing the equity component from 10% to 77%, and put over 70% of the equity portfolios in only five companies. Over the next decade, their book values grew over 800%.
Teledyne sales passed the $3 billion mark in 1980. During the Cold War, government sales reached $800 million. However, a slump in Teledyne business began in 1985. Sales decreased by about $250 million from the previous year.
In April 1986, Singleton turned over the position of CEO. Three years later, again in April, Singleton retired as an employee and officer.
At its peak, Teledyne had revenues of nearly $5 billion. Today, that number stands at $3.1 billion. A person that invested $1 in 1963 with Singleton would have $181 in 1990. All because of a focus on long-term value investing and accretive capital allocation.
3. Buffett and Dempster Mill
In 1956, Warren Buffett saw an opportunity in Dempster Mill Manufacturing, a company from Beatrice, Nebraska, a manufacturer of farm equipment, specifically water irrigation systems and windmills. A hard business, especially considering that this equipment did not differ much from competitor to competitor, back then. Dempster Mill struggled, and the stock was selling at $18 a share, even though it had a book value of nearly $72. Many thought that the company had little earning power. Nonetheless, Buffett began purchasing stock.
He continued to do so for five years. As his stake in the company grew, he wasn’t content with just purchasing cheap stock, and sought to take over control of operations, cut costs, and improve profitability.
In 1961, Buffett sent out a letter to his partners, introducing the company as a producer of farm implements and water systems with sales of $9 million for that year. He further elaborated that the company is only producing nominal profits, due to poor management, and the industry climate.
Buffett originally paid $28 for the stock with $50 of working capital, and a book value of $75. The company’s performance didn’t improve over the years. Nevertheless, Buffett bought more stock until he ended up owning 70% of Dempster Mill (about $1 million). This position represented 21% of his then portfolio.
He brought in Harry Bottle, also known as the doctor of sick businesses, to take over and run the company. Bottle began by laying off 100 employees and selling excess inventory. He kept a keen eye on reducing costs, which, in turn, led to sales growth.
In 1963, Buffett sold Dempster Mill, $80 per share. A tremendous increase from the $15-$30 per share he spent on buying it. The deal netted his partnership close to $2.3 million.